What are Advisory Shares?

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Getting a young company off the ground is a tedious and finance-intensive process. The young company might find itself cash-strapped and unable to pay a qualified advisor their deserved pay rate.

Given that the expert’s advisory role could turn the company’s fortunes around, entrepreneurs have formulated other ways to pay advisors by offering equity in their company for the services they need from qualified services.

Although it seems like a win-win situation for the company and the adviser, it could be a slippery slope that requires careful consideration and understanding before committing to it.

What are Advisory Shares?

Advisory shares are a type of equity compensation given to a company’s advisors instead of, or on top of, their professional fee. Think of them as employee stock options. The only difference is advisory shares are only extended to those vital inception-phase advisors and are quite common among startups.

They are a form of non-equity cash compensation given to advisors for their time, experience, network and strategic insights invested in the budding company.

Even though they are a type of equity ownership, they don’t come with voting rights or a stake in the company’s profits. However, they grant the holder the right to advise the company’s management team. In most cases, these shares are given to experts who provide valuable insight to the company in its early stages of growth.

Who Issues Advisory Shares?

Startup companies are the ones that offer advisory shares to the advisors. When the company is still in the pre-launch phase, it might be challenging for investors to provide capital funding. At this point, the company can use the advisory shares option to take it from concept to launch more efficiently and effectively under the watchful eye of an expert who is then given a piece of the company as compensation.

The equity given to the advisors can vary considerably depending on the expert’s expertise and role. It can also vary depending on how long the advisor and the company work together.

How Advisory Shares Work?

With advisory shares, advisers can purchase shares rather than being given the actual shares. This prevents the company from incurring a potential tax obligation if the advisory shares granted are worth a significant amount.

With advisory shares, the adviser doesn’t obtain voting power or the right to sell or trade shares to receive dividends. In most cases, advisory shares do not entitle the shareholder to any powers at all. Therefore, advisory shares do not carry any risk to the shareholder and are simply considered another form of compensation.

Advisory shares might be a good option for startup companies to get the technical advice and direction they need to stay on the course of success. However, most companies commonly make the mistake of overcompensating the advisors with stock options. Those fractions might not be worth much at the early stage, but as the company grows, they could be worth a fortune. It is better to make alternative or special arrangements, such as offering a three-month trial period, just to be sure that you’re partnering with the right adviser for the sake and success of your business.

One way to mitigate your risk would be to receive startup proposals from startup lawyers. You should also have an advisory board agreement if the adviser serves on the board of directors.

Differences Between Regular Shares and Advisory Shares

Advisory shares shouldn’t be confused with other regular shares. Although both are types of shares and involve splitting the company’s equity, they do have differences.

The main difference between regular and advisory shares is that regular shares are common stock units. They are available for purchase on the public market. Advisory shares, on the other hand, are stock options given experts.

Advisory shares fall under non-qualified stock options or NSOs, which differ from ISOs or incentive stock options given to employees.

The NSOs are given to incentivise consultants, advisors, partners and directors, while the ISOs are stock options for employees.

What are the Types of Advisory Shares?

There are two types of advisory shares;

Restricted stock awards

Also called restricted stock agreements (RSA) in some quarters, these are shares of common or ordinary stock granted to someone. They can be paid for by cash or through the provision of services. These shares are subject to vesting requirements.

RSAs are usually issued in the early stages of a company. Investors can be shareholders upfront and receive the share in exchange for their services.

During this time, the fair market value is extremely low, meaning a lower and more favourable tax outcome for the advisor. Sometimes, the shares can be free to give away, making it a win-win so you don’t incur additional costs.

Stock options

Stock options preserve the right to acquire stock at a predetermined strike price. Advisory shares are almost always categorised as NSOs because of the contractor/service provider relationship involved between the parties.

How Advisory Shares Work

How advisory shares work is detailed in an agreement that is set out in writing, just like any equity-related transaction.

Startup advisor agreement

Once you agree on the details of the transaction with your advisors, an agreement is created detailing the agreement and signed to become a binding contract between both parties.

You can use one of the many agreement templates available or customise for your transaction. However, because this is a legal document, you want it to mitigate legal risks and issues. Some of the provisions you should check in the agreement include the following;

  • The roles, responsibilities and expectations of each party
  • The type of shares and percentage of the company’s total equity
  • The length of service, also called the vesting schedule
  • The conversion mechanism to be used if using options
  • Intellectual property agreements and other proprietary information

During their time, the advisors will have access to sensitive information such as marketing plans, financial documents, and growth strategies. Good advisory shares agreements should find a way to protect the company’s confidentiality and prevent a conflict of interest.

You might also want to consider signing a deed of confidentiality in addition to the advisory share agreement, but most people would consider that overkill.

You can also use a Founder/Advisor Standard Agreement template (FAST) to make the advisory process more efficient for the startup founders.

Advisory shares vesting schedule

The vesting period is the time the advisor must wait to exercise their right to convert the option into a share or stock in the company.

The vesting period should be covered in the agreement to ensure that the recipients are financially and strategically incentivised through a commitment to the company’s overall performance. The purpose of the schedule is to align the two parties.

There are three types of vesting schedules;

Time-based vesting

This schedule requires the advisor to stay with the company for a specified time to claim their stock or option rights. For example, you can have a four-year vesting schedule with a one-year cliff. It means;

  • The stock will vest after four years of service by the advisor
  • The advisor must work for at least one year for any stock to vest
  • The remaining stock will vest increasingly on a monthly or quarterly basis

Milestone-based vesting

Milestone vesting is not time-based. Instead, it is based on completing a task that adds value to your company, triggering the stock or option to vest.

Hybrid vesting

This is a mixture of time and milestone vesting. It requires the advisor to stay with the company for a specified amount of time and complete certain tasks in order for the stock or option to vest.

Who Gets Advisory Shares?

As the term implies, advisory shares are given to startup advisors who are not full-time employees of the company.

The advisors are professionals with industry experience, expertise and networks that can greatly benefit the business and help the founders fast-track learning and reduce mistakes.

Startup advisors can come in many forms, but in most cases, they have specialised skills in various fields like software development, marketing or operations, where they have invaluable information. They have been in the same position as you many times possible and have the knowledge and expertise that could help you avoid the mistakes they’ve made and learnt from over the years.

With the right advisors, it is vital to know how to compensate them fairly to leverage their knowledge and experience for your company’s success.

How Much Equity do Advisors Get?

The amount of equity represented by a share varies widely. Entrepreneurs usually stick around the 5% -10%  range. But there’s no regulatory limit on how much a company can offer.

Individual advisers can receive anywhere from 0.25% to 1% of the company as an incentive to continue providing their technical expertise and strategic direction. However, the actual amount depends on the determined adviser’s contribution to the company’s growth.

Also, an adviser’s equity varies depending on the experience, role and influence in the company. It also depends on how long the two parties intend to be in business together.

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